A recent success story from Jennifer C. – a new Raving Fan of The Jamie Zeitz Team at HomeBridge Financial Services!
Jennifer, a new home buyer, started her search in a challenging inventory market and wondered how she was going to pay for the repairs and upgrades. Not wanting to use her savings to do renovations, it seemed impossible to self-finance such a big project. Then her realtor told her about the FHA 203(k) loan, also known as a “renovation loan.”
What is a FHA 203(k) loan?
A FHA 203(k) loan is a specialized renovation or home improvement loan, offered by the Federal Housing Administration (FHA). It is available to both buyers and refinancing households, and combines the traditional “home improvement” loan with a standard FHA mortgage, allowing homeowners to finance their renovation costs.
Unlike a regular mortgage which bases the loan amount on the current appraisal of the home, a FHA 203(k) loan is calculated on the appraised value of the home or condo at the conclusion of the renovation.
There are two types of FHA 203(k) loans.
The Standard FHA 203(k) and the “Limited” formerly known as a Streamline FHA 203(k).
The Standard 203(k) Mortgage is used for major remodeling, repairs and structural changes with a minimum repair cost of $5,000. A HUD Consultant is required. Consultants work to oversee the process and assist with communication between the lender, the borrower (us) and the general contractor.
The Limited FHA 203(k) may be used for cosmetic improvements, appliances and minor remodeling. The total rehabilitation cost must not exceed $35,000 and there is no minimum rehabilitation cost. Generally, no consultants are required for this type.
How is it like a regular mortgage?
A FHA 203(k) Loan still requires credit approval and proof of reliable income, similar to any other regular home loan, and like most loans, you’ll need money down, but the requirement is fairly low. At the time we contracted for Jennifer, her down payment requirement was 3.5% of the final loan amount (sales price of home + cost of renovation).
However, there are some restrictions that are different.
- With the Standard FHA 203(k), you must use a validated general contractor to manage the improvements and renovations. However, the buyer gets to select his/her own general contractor to use.
- If you use the standard 3.5% down payment, you will carry Private Mortgage Insurance for the life of the loan, regardless of the loan to value ratio. You could choose to refinance out of PMI in the future, but generally there are refinance costs associated with that. If you put 10% down payment, then the PMI can be removed in 11 years.
- There is a set cost for the HUD consultant. However, all renovation costs are rolled into the loan since they are part of the “cost of renovation”.
- You are required to do the work outlined in the scope of work that the appraisal was based on. In other words, you need to be 100% confident that you want to do everything you get the funding to do unless something unforeseen causes a change.
- You are required to fund a contingency budget above and beyond the scope of work. If you don’t use it, it gets credited back to the principal balance of the loan. This shortens the life of your loan, but doesn’t affect the payment.
You can learn more about it on the HUD website.
For Jennifer, we secured a Standard 203K home loan. She purchased the home as-is for $76,000 and expected to invest more than $144,000 to fix her up. HomeBridge Financial required a 15% contingency (since the utilities were not active), bringing the total to about $240,000. (The final number was adjusted for closing costs and our down payment, but you get the drift.) Hopefully, she’ll be able to avoid using the whole contingency since she and her contractor are not expecting much in the way of surprises with the house already being gutted to the studs.
The appraisal came in at $251,600, so away she went with instant equity.